Deep value, contrarian, and Grahamite investment

Iconic Value vs Glamour research receives an update

In a new paper Value vs Glamour: A Global Phenomenon (via SSRN) The Brandes Institute updates the landmark 1994 study by Josef Lakonishok, Andrei Shleifer, and Robert Vishny investigating the performance of value stocks relative to that of glamour securities in the United States over a 26-year period. Lakonishok, Shleifer, and Vishny found that value stocks tended to outperform glamour stocks by wide margins, but their earlier research did not include the glamour-driven markets of the late 1990s and early 2000s. The paper asks, “What effect might this period have on their conclusions?” To answer that question, The Brandes Institute updated the research through to June 2008, examining the comparative performance of value and glamour over a 40-year period, and extending the scope of the initial study to include non-U.S. markets, to determine whether the value premium is evident worldwide.

The research focuses on our favorite indicator, price-to-book value, but also includes price-to-cash flow, price-to-earnings, sales growth over the preceding five years and combinations of the foregoing. Here is The Brandes Institute’s discussion on price-to-book:

Lakonishok, Shleifer, and Vishny on price-to-book

The Brandes Institute hewed closely to Lakonishok, Shleifer, and Vishny’s methods, described on page 3 of the paper:

First, the sample of companies as of April 30, 1968 was divided into deciles based on one of the criteria above. Second, the aggregate performance of each decile was tracked for each of the next five years on each April 30. Finally, the first and second steps were repeated for each April 30 from 1969 to 1989.

We start with the price-to-book criterion as an example. First, all stocks traded on the NYSE and AMEX as of April 30, 1968 were sorted into deciles based on their price-to-book ratios on that date. Stocks with the highers P/B ratios were grouped in decile 1. For each consecutive decile, P/B ratios decreased; this cuilminated in stocks with the lowest P/B values forming decile 10.

In essence, this process created 10 separate portfolios, each with an inception date of April 30, 1968. The lower deciles, which consisted of higher-P/B stocks, represented glamour portfolios. In contrast, the higher deciles – those filled with lower-P/B stocks – represented value portfolios.

From there, annual performance of deciles 1 through 10 was tracked over the subsequent five years. Additionally, new 10-decile sets were constructed based on the combined NYSE/AMEX sample as of April 30, 1969, and every subsequent April 30 through 1989. For each of these new sets, decile-by-decile performance was recorded for the five yeras after the inception date. After completing this process, the researchers had created 22 sets of P/B deciles, and tracked five years of decile-by-decile performance for each one. Next, [Lakonishok, Shleifer, and Vishny] averaged the performance data across these 22 decile-sets to compare value and glamour.

As the chart below indicates, [Lakonishok, Shleifer, and Vishny] found that performance for glamour stocks was outpaced by performance for their value counterparts. For instance, 5-year returns for decile 1 – those stocks with the highest P/B ratios – averaged an annualized 9.3%, while returns for the low-P/B decile 10 averaged 19.8%. These annualized figures are equivalent to cumulative rates of return of 56.0% and 146.2%, respectively.

[Lakonishok, Shleifer, and Vishny] repeated this analysis for deciles based on price-to-cash flow, price-to-earnings, and sales growth. The trio found that, for each of these value/glamour criteria, value stocks outperformed glamour stocks by wide margins. Additionally, value bested glamour in experiments with groups sorted by select pairings of P/B, P/CF, P/E, and sales growth.

The Brandes Institute update

The Brandes Institute sought to extend and update Lakonishok, Shleifer, and Vishny’s findings. They replicated the results of the Lakonishok, Shleifer, and Vishny study to validate their methodology. When they were satisfied that there was sufficient parity between their results and Lakonishok, Shleifer, and Vishny’s findings “to validate our methodology as a functional approximation of the [Lakonishok, Shleifer, and Vishny] framework,” they adjusted the sample in three ways: First, they included stocks listed on the NASDAQ domiciled in the US. Second, they excluded the smalles 50% of all companies in the sample. Finally, they divided the remaining companies into small capitalization (70% of the group by number) and large capitalization (30% of the group by number):

To expand upon [Lakonishok, Shleifer, and Vishny’s] findings we begin with our adjusted sample, which now includes data through 2008. Specifically, we added decile-sets formed on April 30, 1990 through April 30, 2003 and incorporated their performance into our analysis. This increased our sample size from 22 sets of deciles to 36. In addition, the end of the period covered by our performance calculations extended from April 30, 1994 to April 30, 2008.

Exhibit 3 compares average annualized performance for U.S. stocks from the 1968 to 2008 period for deciles based on price-to-book. Returns for deciles across the spectrum changed only slightly in the extended time frame from our replicated [Lakonishok, Shleifer, and Vishny’s] results. Most notably, the overall pattern of substantial value stock outperformance persisted. During the 1968 to 2008 period, performance for decile 1 glamour stocks averaged an annualized 6.9% vs. an average of 16.2% for the value stocks in decile 10. Respective cumulative performance equaled 39.6% and 111.9%.

Set out below is the comparison of large cap and small cap performance:

The paper concludes that the value premium persists for the world’s developed markets in aggregate, and on an individual coutry basis. We believe it is more compelling evidence for value based investment, and, in particular, asset based value investment.

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